Reserve Bank takes the gloves off with rate cut to historic low

The RBA has signalled a more aggressive approach to firing up the economy in the face of global interest rate cuts.

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The Reserve Bank has signalled a more aggressive approach to firing up the economy in the face of global interest rate cuts, taking it a step closer to launching quantitative easing, even though it risks reigniting debt-fuelled speculation in the property market.

In setting out its case for a widely expected 25 basis point cut in the cash rate to a historic low of 0.75 per cent after its October board meeting, the RBA said a long period of weak household income growth continued to crimp consumer spending, forward indicators suggested jobs growth would slow, and risks to the global economic outlook were causing a “trend to lower interest rates globally”.

Despite further signs of a turnaround in established housing markets — highlighted by surging prices in Sydney and Melbourne which led a strong 1.1 per cent jump in CoreLogic’s house price index last month — the RBA noted that new building activity has weakened and credit growth remains low.

While repeating that a “an extended period” of low interest rates was likely to be needed, RBA governor Philip Lowe said the RBA aimed to “reach full employment” and “achieve the inflation target” of 2-3 per cent. Last month he merely spoke of making “progress in reducing unemployment” and achieving “more assured progress towards the inflation ­target”.

“The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time,” Dr Lowe said.

The Australian dollar fell more than half a cent to a decade low of US66.72c as three-year Australian Commonwealth Government bond yields dived to a record low of 0.59 per cent after the rate cut and weak US ISM manufacturing data overnight.

Shares surged, with the benchmark S&P/ASX 200 index up 0.8 per cent to 6742.8 points amid gains in foreign income earners — particularly healthcare — and income stocks in property and infrastructure.

Banks were reluctant to pass on the full interest rate cut to borrowers amid pressure on margins, with CBA cutting its standard variable mortgage rate by just 13 basis points and NAB cutting 15 points.

But analysts rushed to predict another interest rate cut from the Reserve Bank this year, with some predicting a cut to 0.5 per cent in November and potentially 0.25 per cent by February.

“We maintain our forecasts for 25 basis point cuts in November and February and now see the cash rate hitting a record low of 0.25 per cent,” said Nomura interest rate strategist Andrew Ticehurst.

Mr Ticehurst said the RBA “appears to have raised the hurdle on what it is trying to achieve” on jobs and inflation, but on the basis of his view that rate cuts won’t achieve its objectives, he now sees a move to unconventional monetary policy easing as “slightly more likely than not”.

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He added that the extent to which banks passed on the RBA’s latest rate cut and the chance of fiscal spending after the mid-year review in December could determine how much easing was needed.

The RBA’s Dr Lowe late on Tuesday defended the central bank’s decision to cut rates for a third time this year amid criticism it will do little to stimulate the economy and could have “undesirable side effects”.

Dr Lowe said that the way interest rate cuts worked on the economy had changed, but they still helped to make “more assured progress” towards the RBA goals of full employment and meeting the 2-3 per cent inflation target.

“But, importantly, the Board also recognises that monetary policy still works,” Dr Lowe said in a speech to the RBA board dinner in Melbourne.

“It works to support employment, jobs and income growth across the economy.

“(Tuesday’s) decision, together with our decisions in June and July, will assist on each of these fronts. In doing so, these decisions will promote the collective economic welfare of the Australian people, which we need to remember is the ultimate goal of monetary policy.”

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Ahead of Tuesday’s cut, the RBA was warned by economists, former RBA board members and executives and former Treasurer Peter Costello that further cuts would have no effect on the real economy.

Dr Lowe said the key to returning rates to more normal levels would be addressing the reluctance to invest rather than save.

But he said this was “mainly a task for governments and businesses, not for central banks” and that further structural reforms were needed to lift productivity in the economy and restore wages growth.

AMP Capital’s head of investment strategy and chief economist, Shane Oliver, said the RBA’s pursuit of full employment suggested that the RBA had “left the door wide open to further easing”.

“Full employment probably means unemployment around 3.5-4 per cent and underemployment around the same level, so we have a long way to go,” he said.

The RBA has signalled that if more stimulus were needed after cutting the cash rate to the “effective lower bound” of monetary policy — somewhere between zero and 0.5 per cent — it is fully prepared to use “unconventional” policies like quantitative easing — bond buying — to achieve its goals.

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The RBA is unlikely to cut the cash rate to zero or negative because banks are unlikely to fully pass on such rates to borrowers, according to Dr Oliver. Negative rates hadn’t worked in Europe and Japan and would be bad for confidence. “Rather once rate cuts are exhausted at 0.25 per cent the RBA would likely turn to other unconventional monetary policy measures if needed next year, including quantitative easing,” he said. “This is not our base case but the probability … is rising.

Similarly, with a moderation in employment growth forecast by the RBA, its full employment objective is “looking increasingly challenging with similar implications for progress on inflation,” according to RBC Capital Markets head of Australian fixed income strategy, Su-Lin Ong.

with Andrew White